Thursday, May 27, 2010

“GET a LOAD of THIS XXX!!!!”: The Least Publicized Article You Will Read Today

The least publicized article you will read today arrives courtesy of the SEC, which shut down an effort by a Disney communications insider to sell advance information on Disney earnings reports to hedge funds.

Here’s how the Wall Street Journal is reporting it:

Federal authorities alleged Wednesday that a Walt Disney Co. executive assistant and her boyfriend engaged in a ham-handed plot to sell Wall Street traders inside information, first offered in a chirpy missive sent to dozens of investment companies.

"Hi, I have access to Disney's (DIS) quarterly earnings report before its release on 05/03/10," the March 5 letter began. "I am willing to share this information for a fee that we can determine later."

It is, of course, a heart-warming thing to know that not all SEC employees are so absorbed in surfing for porn on their office computers they can’t get their jobs done.

That activity, while not normally associated with Good Government, engaged at least 33 SEC employees over a 5-year period, including 17 “senior SEC employees, earnings between $99,000 and $222,000 a year,” according to last month’s report by the inspector general.

Our tax dollars at work, indeed.

But the key to breaking the Disney cash-for-information ring actually was the hedge funds that received the email in the first place:

The alleged plan went awry. Instead of taking the bait, "multiple hedge funds reported the illicit scheme," the Securities and Exchange Commission said in a press release.

—The Wall Street Journal

That is not how the investment world is supposed to work.

According to uninformed Congresspersons (is there any other kind?), incompetent CEOs, conspiracy-theory-spinning web sites and their equally loopy readers, the hedge funds of America are a latent evil within a corrupt system—the heart of darkness at the end of the long, sad journey into the country’s financial soul.

Yet it was thehedge funds that forwarded the Disney goods to the Feds in the first place.

(Okay, maybe they needed to use a subject line such as “GET a LOAD of THIS XXX!!!!” to get somebody’s attention…but still, the Feds did their job.)

And that’s why you won’t read much about the hedge funds’ role in this affair: it’s too close to the truth about hedge funds, which is that most of them have nothing to do with the kind of drama the Galleon case exposed.

Indeed, and not for nothing, most of the SEC has nothing to do with the kind of incompetence the Madoff case or the recent porn-reading nonsense exposed, either.In fact, for an eye-opening look at what the Feds have to go through to bring down an obvious scam, not to mention what a hard-working hedge fund goes through to bring obvious scams to the attention of the Feds, we suggest reading Richard Sauer’s “Selling America Short.”

Sauer’s informed (he was an SEC attorney before he joined a hedge fund) and detailed set of stories will make you sick, but they’ll also make you appreciate what a no-win position the Feds occupy in America’s—and the world’s—byzantine financial regulatory schema, not to mention how the bad behavior of Goldman Sachs took down a hedge fund on the cusp of making a bundle for its investors thanks to prescient bets on a financial crisis.

We’ll have a review of it once we finish our current Berkshire Hathaway series, but in the meantime, get a hold of it and start reading.

"In April 2001, Zilkha, now 41, was planning to leave Microsoft and join Pequot when Samberg e-mailed him, seeking information on whether the company would miss quarterly earnings estimates. “Any tidbits you might care to lob in would be appreciated,” Samberg wrote, according to the SEC’s claim. Zilkha contacted colleagues, learned that earnings would meet or beat expectations, and advised Samberg to buy the stock, according to the agency’s complaints. Samberg invested in Microsoft stock options, helping Pequot funds generate $14.8 million in illegal profits, the SEC said. ,,, Samberg wrote in a message to Zilkha, “our tech group has a very dim view of pc demand, and consequently msft,” according to the SEC. “in fact, they are short the stock in one account, while it is my largest long. (I shouldn’t say this, but you have probably paid for yourself already!)”"

The hedge fund world won't be destroyed by regulation. Okay, they're rightly going after the correct tax approach to your carried interest. But, jeesh, you've got to get off the fear of being painted the bad guy.

Purely on the basis on personal acquaintances, I'd guess 80% or more of today's hedge funds actually hedge. In other words, they use short positions and options to both make money on the short side as well as to hedge their portfolios against a downturn.

During the 2004-2007 period, that portion was greatly diminished by two things.

First, a great many portfolio managers began going out on their own to open up what they called "hedge funds." They were hedge funds in name and incentive fee structure only: in fact, they were what we called "closet long" funds, because they didn't really hedge or know how to hedge. They mainly wanted the fees.

That was one reason the markets fell so hard in 2008--those guys got blown out in the crisis, because they didn't know what they were doing.

Second, during that long bull market, a fair portion of hedge funds decided--quite rationally at the time, but not in hindsight--that the cost of hedging a portfolio wasn't worth missing the upside. So they cut down on their short position and hedges.

That was another reason for the 2008 crash.

Today we seem to have returned to an earlier time, when most hedge funds actually hedge.

JeffThanks for sharing this as I do recall seeing a headline, but did not read the story. However, I strongly disagree with your point that the hedgies deserve some credit for being a whistleblower in lieu of acting on this "information". What choice did they really have in light of the fact that these geniuses sent a letter instead of doing everything verbally? In other words, had they acted, the letter would have been used to completely nail them as well if the SEC ever got wind of this. Do you really think this story would have had a similar ending if Bonnie and Clyde made sure that there was nothing in writing? I do wonder how many of these hedgies actually went to the compliance guy for an opinion.

I agree with you totally - most hedge funds essentially act as better regulators than the actual regulators act. That is, they find companies doing things that are unethical or misleading and short the stocks. Their short positions act as incentives to inform the public of this untoward behavior. Of course there will always be bad actors when there are such large amounts of money are involved. But the incentives hedge fund managers have are much more pure than say a prop trader at an investment bank.

I think Tim had a point. If it hadn't been solicited in such a ham-handed fashion, one or ten of the 33 recipients might have acted. And had the solicitation been slicker, the compliance officer would likely have been consulted. I have no special complaint regarding hedge funds as I believe the same would have been true for a pension fund manager, mutual fund manager or a retail stockbroker.

This post did not strike me as Yahoo Message Board material (your standard put down) but rather as reasonably healthy skepticism.